I really don't see much difference in outcomes between IOUs/bills of credit and drachmas, which are also IOUs in a fiat system.

The most likely scenario for the IOUs is that Greeks will arbitrage them for what few taxes they pay. Get paid in the private sector with a mix of euros and IOUs, keep the euros for private transactions, and use the IOUs to pay taxes at a discount.

You can count on Greece to issue far more IOUs than it gets back in tax revenues, so the IOUs will inflate away just like the resurrected drachma would. Ironically, this would functionally cut government wages and pensions - something the Greek government has fought tooth and nail during negotiations with the troika. It should come as no surprise that a government would resort to that tactic.

Nobody in their right mind would accept those IOUs in exchange for euros except at a steep discount which means Draghi will figure out a way to pay full price for them if it preserves the power structure of the EU/ECB. Everyone is starting to walk back the tough talk already: Schauble says Greece can stay in the euro if it defaults, Juncker wants to keep the deal in play, Greece is courting the ESM.

They WILL find a way to compromise because none of the people in power want to lose power. Josh brown said this in August 2012:

"But here’s the part where I help you. Because while I have no special expertise or experience in forecasting the vicissitudes of core European diplomacy and socioeconomic policy, I do know white people. And I know wealthy white people, in particular. And wealthy white people, American or otherwise, can always be counted on to compromise at the last moment so as to preserve the status quo. And that compromise will typically involve whichever option is the least painful, even if it means that more work must be done in the future (the proverbial can-kick). And we know that euro printing, even if it means a bit of inflation for the German middle class to wrassle with, is probably worth it if the task is preserving the hegemony of the creditors, rentiers, landed gentry and aristocracy.

And so eventually, no matter how scary the headlines become or how volatile markets become in the short-term, you can expect a compromise that the wealthy and powerful elites (read: the markets) can live with."

"I really don't see much difference in outcomes between IOUs/bills of credit and drachmas, which are also IOUs in a fiat system."

The difference is that drachmas would be used as a medium of exchange to purchase goods / services. That need not be the case with "bills of credit".

"Nobody in their right mind would accept those IOUs in exchange for euros except at a steep discount which means Draghi will figure out a way to pay full price for them if it preserves the power structure of the EU/ECB."

The Greek government would only need it's own citizenry to purchase them.

You keep thinking of these IOUs as bonds, which they are not. They are like any fiat - an IOU that pays no interest, like the dollars in your pocket.

They are NOT selling the IOUs. They would issue them in lieu of euros. Maybe you could buy them at a discount on a secondary market and hope for appreciation but they are by no means an investment per se.

Isn't "printing IOU's" the same thing as a zero (or at least low) interest bond issue? Even if the Greek government forced public employees to take these bonds, what private business would accept them, given that their bond market is already essentially dried up? Even if there was some chartalist domestic value, it'd be heavily discounted in comparison to the cash Euros that Greeks currently hold, and of almost zero value to foreign parties. Maybe the Greek government could force this as some sort of short term expedient bridge currency with a crazy high seigniorage , but it's hard to see how it solves any actual problems.

That is why the Greek government should not force people to take them, It should sell them (for Euros) instead. A private business (or individual) might purchase them if they have a positive rate of return and could be used to extinguish a future tax liability.

It solves an actual problem (too much external debt) when it uses the proceeds of that sale to retire the external debt.

I think Kashyap misses the bigger point - that is Greece's problems emerge from structural trade and balance of payment's deficits - not government deficits. The problem lies with the country's industrial structure. Countries like the US or UK can get away with running government deficits, even with external payments deficits; small open agrarian economies whose export receipts are substantially less than imports cannot sustained continually large government deficits and are at the mercy of foreign creditors. These are the sort of things economic theory cannot explain well and you need to know some history and basic political science about why this is true for some countries and not others.

Allowing a default and a return to the Drachma will give a temporary solution. But it is only a return to the pre-Euro situation in Greece. It is not a recipe for lasting prosperity.

The only solution is political and fiscal union in Europe. This was derailed in the early 2000s by the expansion eastwards (ex-communist bloc) which added over 100 million much poorer countries to the union. The rushed entry was a British led effort concerned about French domination of the EU. However Britain now has political problems related to the huge Polish influx of cheap workers which is behind the rise of far right parties and anti-immigration and anti-EU sentiment in the UK and elsewhere. This has forced the UK into referendum on EU membership in 2017.

What could happen is a two-speed Europe, where the Eurozone goes into fiscal/closer political union and the non-Euro periphery which includes the UK stays in a less integrated periphery.

Paul Krugman is at it again. He just thinks that a devaluation will solve Greece's problems.

Pre-Euro, devaluation and default never solved Greece's problems. It simply cannot afford the imports it needs to produce the exports it needs to get the foreign exchange to buy those imports. It is not a long term solution. It actually worsens your trade deficit and is highly inflationary, devaluing the purchasing power of your currency further. This was the catch -22 of pre-Euro Drachma Greece. A story of endless defaults, inflation, and little industrial development.

The bigger point here though is the problem of people who take gadgets off the shelf to look at real world problems without country specific or historical knowledge. It is a big problem with the education of many economists and policy makers.

Paul Krugman seems to want to prove the virtues of Open Economy ISLM and Optimal Currency Area Theory with a vengeance. His latest now is to connect the problems of Finland to the Euro and economic policy "straightjacketing". The problems of Nokia and Finland is basically one where a small economy let a company get too large and it became dependent on it. This has very little to do with the Euro, and nor would a devaluation be likely to fix this problem.

Austerity for sure is a tragedy for the Greek people of which they should not be expected to further submit to, and I hope the US intervenes to put an end to it. However, a return to the Drachma is not the long term answer. Hopefully the present Eurozone (not the whole of the EU) will now push towards fiscal and political union.

For Greece to stay in they'd have to have a debt moratorium, be allowed back in the ELA and get fresh money. That solution would last as long as the moratorium given current economic policy. If they reformed, they'd have a chance to grow again. If they stay with Syriza, things may come unstuck again.

Fundamentally, unless Greece stops being Greece, economically speaking, they'll eventually have to Grexit.

If there's one thing I feel confident about as we ride the manic-depressive on-again-off-again roller coaster it's that the EZ and Greece have one thing in common: both sets of leaders want to preserve their power, and that means Greece stays in the EZ.

Juncker wants to protect his EC power. Merkel is afraid Greece will fall into the arms of Vladimir Putin. The Greeks want to stay in the euro because they don't realize that the agony of inflation under the drachma and the agony of austerity under the euro leave them with pretty much the same level of economic desolation and daily misery. Their brief flirtation with nirvana in the early days of the euro is gone forever.

Greece and its adversaries are coming at it from different directions but keeping Greece in the euro is the one thing they can agree on at the leadership level. What their respective citizens think is secondary to the retention of power at the top.

In simply monetary terms, a Greek default or way out from the Eurozone would be very nearly a nonevent for whatever is left of Europe or the world: With an expected total national output of about $250 billion, the nation's economy speaks the truth the measure of Connecticut or Louisiana. The default by Greece on its universal obligation, which formally happened Tuesday at midnight Central European Time, 3 p.m. Pacific, won't make any difference much to all that really matters of such real lenders as the European Central Bank.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!